What is Salam in Islamic Banking

Salam contract is a sale contract whereby the purchaser pays the price in advance and the delivery of subject matter is postponed to a specified time in future”. Salam in Islamic banking may also be defined as: “A type of sale in which the seller undertakes to supply goods at a future date, against an advanced spot price, paid fully in cash”.

Elements of Salam Contract:

There are 4 key elements in this contract:

  • Buyer,
  • Seller,
  • Cash Price, and,
  • Purchased Commodity.

Background of Salam:

Before prohibition of interest, farmers used to get interest based loans to harvest; and caravans for purchasing commodities. After prohibition of interest, they both were allowed to do this contract, to get money in advance.

Salam as an Ancient Form of Forward Contract:

When Prophet Muhammad (Peace Be Upon Him) migrated from Makkah to Madinah, it was found that people are used to pay in advance for fruits and dates. Which are delivered within one, two, and three years’ time. But, such a sale was used to carry out without specifying the quality, measure, weight of commodity, or the time of delivery. So, the Prophet Muhammad (Peace Be Upon Him) ordained that:

“Whoever pays money in advance for fruit to be delivered later, should pay it for a known quality, specified measure, and weight of dates or fruit of course, along with the price and time of delivery”.

salam in Islamic banking

Its’ Comparison with General Rules for Sale in Islam:

According to general Islamic Shariah rules, a sale must fulfill following three conditions. However, only the Salam and Istisna are exceptional from these conditions:

  • Commodity for sale must exist;
  • Seller should acquire ownership of that commodity; and;
  • Commodity must be in physical or constructive possession of the seller.
salam contract

Applications of Salam in Islamic Banking:

It is basically a mode of finance for farmers and small traders. It is used by micro banks and financial institutions, to support small industry. It is mostly used for:

  • Agriculture financing;
  • Working Capital Financing;
  • Commercial and industrial financing;
  • Export Financing; and;
  • Operations and capital cost financing.

Parallel Salam:

After the execution of Salam agreement with one party, buyer or seller executes another Salam contract with third party. Parallel Salam contract is allowed with third party only. They must be two different and independent contracts, and these two contracts cannot be tied up.

Parallel Salam Example:

Let us understand it with the help of an example:
Bank purchases 500 Bags of Rice from “Ali” through Salam, with full prepayment and to be delivered on June-30th.

  • “Ali” delivers 500 bags of rice to Bank on June-30th.
  • Bank sells this commodity to a Third-Party, called “Company” on credit.
  • After taking its delivery on an agreed date, Bank delivers it to “Company”.
  • After taking delivery from Bank, the “Company” signs a promissory note against payment, on an agreed specified time.

Note: This lecture is a part of Islamic banking courses, which is designed for the diploma Islamic banking and Islamic finance degree programs at AIMS. An Islamic financial product, which is widely used for asset financing is diminishing musharakah.

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